The days of protecting major national currencies in Africa are over
From the second quarter of 2022, the US dollar’s global rapid appreciation negatively impacted the finances of government’s of developing nations collectively. Many African countries foremost among them Nigeria, Ghana and Egypt, burned through billions of their foreign reserves every day, as they attempted to defend their currencies against the USD. It is estimated that developing nations, prominent among them African countries, lost approximately $400 billion in 2022 defending their currencies against the appreciating dollar. But, why did these developing nation’s do this?
With the current financial paradigm, several African nations will now see extended periods of exacerbated inflation, and deepening poverty. (Ali Greeff/AP)
When Ministers of Finance, and Central Bank governors across the African continent start seeing their national currencies devaluing by record amounts, they did what they could to stop the bleeding by creating artificial demand for their paper. They did this by buying their own national currencies with their foreign exchange reserves to stabilise their exchange rates. And, let’s take a moment to understand why.
First, and foremost, these national currency depreciations, that resulted primarily from the appreciating dollar, were reducing the purchase power parity (PPP) of their citizens in unparalleled amounts. If you had your life savings in Nigerian Naira, Ghanian Cedi, or Egyptian pounds, you saw your life savings decline in PPP terms against the US dollar from 30 - 50 percent in the last six months of 2022. This meant for the average middle class household in these developing African countries, that their lives were forever altered unless their national currencies appreciate once more. Things the middle class once could afford, like international travel, overnight became so out of reach that it has now become next to impossible. Effectively, the middle class found itself being pushed to the threshold of poverty by no action of their own.
Inevitably, this middle class of these nations will have felt a pinch that will lead them to spend less, decreasing aggregate demand and consumption, and leading to an inevitable increase in domestic unemployment. Which Minister of Finance or Central Bank Governor would want this for their people, let alone for their own political future? So, using their foreign exchange reserves to buy back their currencies seemed sensible at the time.
Second, Minister’s of Finance and Central Bank Governors, as they saw their currencies depreciate, would worry about their foreign exchange denominated debt stock. If your national currency is worth less, it will cost you more to buy the hard currencies you need, mostly greenback, to service and pay your outstanding foreign exchange debt. Again, burning through some more of your foreign exchange reserves to protect your currency was an attempt to manage the size of your short and long term debt repayments. At the time, I’m sure this seemed like a reasonable thing to do.
Third, Minister’s of Finance and Central Bank Governors had to defend against inflation. Most developing African nations depend on imports, primarily foodstuffs and staples, to feed their citizens. Serious devaluation equals import inflation and enhanced levels of poverty. Using your foreign reserves to buy back your own currency, to stabilise it, would have seemed to be logical at the time as it would have been perceived as anti-inflationary.
But, alas for many African nations they burned through their foreign exchange reserves attempting to protect their currencies, until their levels became precariously low. Their only remaining alternative was to turn to the International Monetary Fund (IMF) for support as they began to run out of foreign exchange. The IMF, using their standard formula, was happy to provide assistance through standby agreements most of which required the free float of several major currencies on the African continent.
This means for select nations, using your foreign exchange reserves to protect your currency, is now a thing of the past. But, how can countries with a very weak level of exports contain future devaluations without buy backs using their foreign exchange reserves?
After all, these countries are small players in the world of global finance. Their currencies will move like the wind against the greenback and the Euro depending on so many exogenous factors. And, how much can you do using interest rates to control domestic inflation with some countries on the African continent now giving up to 30 percent annual returns on savings deposits to curtail the money supply.
Without doubt, several African nations will now see extended periods of exacerbated inflation, and deepening poverty. And, the question remains what could any of the impacted countries have done to avoid this quandary? From my perspective, not much, and worse still with a free float, there won’t be much they can do to avoid similar calamities in the future.